~ The Budget 1993-94 made Indian Rupee fully convertible on trade account and LERMS was withdrawn. Subsequently, in April 1994, Rupee was made fully convertible on current accountas well. Thus, all transactions of goods and services were converted at market rate without any restrictions.

*DISADVANTAGES OF FLEXIBLE EXCHANGE RATE:

~ Flexible exchange rate has the following negative effects:-

i) It creates uncertainty for exporters and importers as they remain unsure about the amount payable or receivable.

ii) It discourages investment and borrowingsdue to uncertainty and thus hampers economic growth.

iii) Under flexible exchange rate Macro-economic policies lose stability as they become prone to the wild fluctuations in the exchange rate.

iv) Flexible exchange rate may also give rise to irrational speculation that leads to destabilisation of the exchange rate.

v) It also results in poor international co-operationsince each country allows the exchange rate to be determined in the market that does not bind them to co-operate with other nations.

vi) Flexible exchange rate is inflationary in natureas it results in frequent increase in prices due to depreciation of traded goods. Moreover, appreciation of goods does not bring about a parallel reduction in prices.

~ To minimise these disadvantages, India has adopted the managed flexible exchange rate wherein the RBI selectively intervenes in the market to prevent wide fluctuations.

*EXCHANGE MARKET INTERVENTION:

~ ‘Exchange Market Intervention' is defined as the sale or purchase of monetary authorities with the aim of changing the exchange rate of their own currency vis-a- vis on or more currencies.

~ If there is too much demand for foreign currency, that currency will appreciate too much and depreciate the domestic currency. At this point, the central bank intervenes by releasing the foreign currency (from its reserves) in the market to stabilize the exchange rate.

~ Similarly, if there is too less demand for foreign currency, that currency will depreciate and the domestic currency appreciates too much. At this point, the central bank intervenes by purchasing foreign currency from the market to stabilize exchange rate.

*ARGUMENTS IN FAVOUR OF EXCHANGE RATE INTERVENTION:

i) APPROPRIATE EXCHANGE RATE:

~ The central bank may be in a better position to gather all the relevant information than the other participants in the market. Hence it can appropriately predict the future course of policies and their implications on the exchange rate. So, it can plan its intervention in the market according to the situation and influence the exchange rate. In absence of intervention, the market may indulge in speculation due to lack of accurate information.

ii) CONTROL OVER DISTORTIONS IN ECONOMIC ACTURTIES:

~ Exchange rate which deviate from the real exchange rate (in relation to the purchasing power parity) may lead to distortion in resource allocation between external and domestic sectors.

~ Either undervaluation or overvaluation brings in uncertainty and affects investment decisions. This can be controlled by intervention of the monetary authorities by making necessary adjustments in the exchange rates.

iii) SMOOTHENS ECONOMIC ADJUSTMENT PROCESS:

~ A persistent surplus or deficit in the balance of payments leads to changes in the exchange rate to correct the disequilibrium.

~ These changes may result in disturbances in the domestic economic activities.

~ Thus, RBI's intervention majorly depends on the size of foreign exchange reserves. The adoption of full convertibility requires a large amount of foreign exchange reserves for intervention operation.

~ Under globalisation, exchange rate is likely to become highly liberal, thus increasing the responsibility of the central banks.

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Forex Trading
FAQ's...

You may find
useful the information below containing questions that readers
have posted relating to Forex that our members have replied to...

28 Aug 2010 10:12:49 AM

Q1.
Explain what foreign exchange rate is?

I know what exchange rate is but what is foreign exchange rate? It would help with a bit of explanation please.
Thank you
I mean foreign exhange sorry. Foreign exchange is different than foreign exchange rate right?

The best
answer for Q1...

It's the rate at which you can exchange one foreign currency currency for another.
Example 1.00 British Pound = 1.21607 EURO

24 Aug 2010 8:49:45 PM

Q2.
How supply and demand law determine the foreign exchange rate?

It is making sense and easy to understand supply and demand law to determine the price of the good in a market,but it is hard to understand how supply and demand law determine the foreign exchange rate..please explain...

The best
answer for Q2...

The more people want/value a particular currency, the more it costs in terms of other currencies. Hence, it's just like anything else sold on a market. If people want Korean Won more this month, then Korean Won will cost more in terms of Dollars, Euros, etcetera.
This leaves open the question (which does not necessarily have to be answered!) of why people will change their demand for a particular currency. One reason would be because of increased demand for the things that currency can buy. The more people want to purchase Korean goods for consumption, the more the Won goes up. The more people want to invest in Korean businesses, the more the Korean Won goes up. And, in the contrary direction, if Koreans demand more foreign goods, then they will sell their Won and the price of the Won will go down relative to whatever currency they are demanding.
Changes in the supply of various currencies can be very complex, and difficult to predict, measure, or even roughly estimate, but they have the same effect on pricing as any other supply variance.

8 Aug 2010 10:24:16 PM

Q3.
International wire/ Which bank has the best international foreign exchange rate (not the fee)? For import/ ex?

Which bank has the best international foreign exchange rate (not the fee)? For import/ export companies, exchange rate is very important--which bank would have the best fx rate for international wire? Please let me know if you know!

The best
answer for Q3...

banks generally dont give good rates. dealers such as schneider fx, or moneycorp are better.

10 May 2010 11:23:23 PM

Q4.
What is the best website or online gadget to show the dynamic (changing) Foreign Exchange Rate?

The gadget will show the current Forex Rate for any pair of currency at a given time and will also change the display the moment there is any change in the market.

I am going to Mexico soon, and I have just looked up the rate between the USD and Mexican Peso. This was the answer: 1.00 USD= 12.8729 MXN. 1 MXN= 0.0776824 USD please explain in "for dummies" terms, what this really means. I don't understand what it really means. Also, is this a good exchange rate?

The best
answer for Q5...

Since you're american, every dollar (1 USD) you exchange, you will get 12.9 mexican pesos.
Even though the american dollar is widely known currency around the world, by exchanging your money to pesos, you will be using their currency.
I don't know if the exchange rate is good or not, it will fluctuate depending on the economy.